BIT: On The Lookout For A Cheaper PIMCO Alternative
Summary
- BIT is a multi-sector fixed-income CEF with a similar allocation profile to taxable PIMCO CEFs.
- On the plus side, BIT has delivered a very strong 2020 NAV return, outperforming PIMCO CEFs. Its discount is also significantly wider, and it should be resilient to higher rates.
- The downside is that the fund's longer-term NAV returns trail PIMCO CEFs, and its distribution coverage is on the low side.
- Overall, BIT may look attractive to investors who are concerned about a market fallout from rising rates as its wider discount and negative duration should prove supportive.
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This article was originally released to Systematic Income subscribers on 18-Mar.
PIMCO taxable CEFs continue to find a home in many investor portfolios. However, the funds' valuation, which are approaching a 15% average premium, is pushing some investors to look elsewhere for cheaper alternatives. In this article we take a look at the BlackRock Multi-Sector Income Trust (NYSE:BIT) which has a similarly broad allocation profile and a similar elevated leverage level. The fund is trading at a 3.1% discount and an 8.31% current yield.
Our main takeaway is that BIT has a number of attractive features, such as its relatively low management fee compared to the PIMCO funds, a more attractive valuation and a very low duration which should help it in a rising-rate environment. The fund also proved relatively nimble in navigating the COVID crash, sharply outperforming PIMCO CEFs in 2020.
The downside of BIT is its longer-term underperformance against PIMCO CEFs which is likely due to its lower duration stance. The fund's risk-adjusted returns are also on the low side.
Overall, BIT may look attractive to investors who are concerned about a potential market fallout due to sharply rising rates. The wider discount of BIT as well as its low duration stance should allow it to perform well relative to the PIMCO suite.
Performance In Context
In terms of historical returns, across a number of different time frames, BIT has tended to underperform PIMCO CEFs, with the exception of PIMCO Strategic Income Fund (RCS).
Source: Systematic Income
The key drivers of returns are sector allocation, leverage and fees, roughly in that order. BIT appears to have a higher investment-grade allocation than most PIMCO CEFs (with the exception of RCS), at a lower duration, at a leverage level roughly in the middle of the pack and at a fee on the lower end of the PIMCO suite. In this context, the fund's relative performance makes a lot of sense. As a side note, we can't confirm the actual credit rating portfolio allocations of PIMCO funds because PIMCO does not disclose credit rating profile of its funds outside of the institutional investor audience.
The fund's allocation is broadly similar to that of the PIMCO CEFs with a few differences. For example, BIT has a higher allocation to high-yield corporate credit and a higher allocation to agencies. Leverage levels are not very dissimilar, though the leverage of BIT is understated due to its sizable dollar roll position.
Source: Systematic Income
If we take a look at the entire stretch of total NAV returns starting from the date when we have the data for all funds, we get the following picture. BIT does come in last in the group, though it's not a million miles away from the lower-performing PIMCO funds.
Source: Systematic Income
BIT did keep up with the lower-performing PIMCO CEFs for a while but appears to have derisked somewhat in the second half of 2019. As of April 2019, the fund was running at a 68% investment-grade allocation - much higher than the PIMCO CEFs.
This derisking had two consequences. First, it meant that BIT missed out on the strong rally at the end of 2019/start of 2020 but then made up for it in 2020.
Source: Systematic Income
The behavior of BIT through and past the COVID drawdown was very peculiar. BIT has the largest NAV drawdown which is surprising given it was running at around 40% IG allocation as of the end of October which is the latest data we have prior to the COVID crash. The second surprising thing about the performance of the fund was that its bounce back was incredibly sharp, outstripping that of the other PIMCO CEFs. For example, the PIMCO Dynamic Credit and Mortgage Income Fund (PCI) had a similarly large NAV drawdown in March but was unable to spring back due to its significant deleveraging in March.
Source: Systematic Income
BIT does not appear to have deleveraged strongly. Its borrowings were less than 4% lower in April-2020 compared to October-2019. Another likely driver of its strong comeback was a rotation from Treasuries to mostly A-rated corporates.
So far in 2021, BIT has generated a similar NAV return to the PIMCO CEFs in aggregate.
Source: Systematic Income
In our view, this is due to the combination of the fund's higher-quality allocation, which detracted from returns this year, and its unusually low duration which added to returns. The two drivers roughly offset each other relative to the PIMCO suite which tends to hold lower-quality assets at a higher duration.
The chart below captures the fund's official duration as well as its empirical duration. The fund's duration of -0.9 is the lowest of the over 200 CEFs that publish duration statistics and that we track. The chart shows that while the fund's official duration is 7 lower than the average of the PIMCO CEFs, its empirical duration is only about 3 lower. This echoes the quality allocation differential where the likely lower-quality profile of the PIMCO funds lowers their empirical duration relative to that of BIT.
Source: Systematic Income
The NAV return of BIT on days when risk-free rates spiked up shows that it is more resilient than the NAVs of the PIMCO funds which echoes its lower duration stance.
Source: Systematic Income
There are several ways that the fund achieves a negative duration:
- floating-rate assets such as loans, CLOs, ABS and MBS;
- interest-only MBS strips;
- CDS rather than bonds in some instances;
- Treasury and Euro-Dollar futures;
- options of interest rate futures and swaptions; and
- interest rate swaps.
Our view here is that the fund is, arguably, overegging it in its rate hedges. Not only does it appear to be the only CEF with a negative interest-rate duration, its empirical duration is even further below zero which seems excessive. And although shortening up on duration worked well in retrospect, this shift in its rate position has not caused the fund to outperform either PIMCO CEFs or the broader multi-sector CEF exposure where the fund also stands in the middle of the pack this year. A two-pronged strategy of a lower quality allocation (which would have lowered empirical duration without an additional cost) alongside very long-dated e.g. 30-year payer swaps (a strategy that PIMCO funds use) would have performed much better and generated more income for the fund.
The fund's net investment income has steadily decreased even if its distributions have remained fairly steady over time and actually increased in 2019. This means the amount of ROC within the distributions have grown.
Source: Systematic Income
The fund's 3-month rolling coverage over the past 9 months has moved in the range of 65-75% with the latest reading at 69% as of January.
Source: Systematic Income CEF Tool
The fund's current coverage suggests that its NII yield on price (what we call covered yield) is around 5.76% versus the 8.3% headline distribution rate. The covered yields on PIMCO CEFs tend to be closer to 6-7% with some exceptions (such as PCM with a covered yield of 9.5% due to the fact that much of its legacy non-agency RMBS portfolio is not repaying par due to historic losses).
The cost of the fund's hedges is likely not included in its net investment income which suggests that the fund's relatively low coverage is actually overstated. It's difficult to tally up the running cost of the hundred or so interest-rate derivatives in the BIT portfolio but a back-of-the-envelope cost for shortening the fund's duration probably comes to around 0.7% on NAV which means its covered yield is closer to 5%.
In terms of discounts, the PIMCO CEFs continue to trade at significantly higher premiums than BIT.
Source: Systematic Income
The key drivers of fund discounts are fund fees, leverage levels and cost of leverage. These features are not sufficiently different between the PIMCO CEFs and BIT to warrant the historical divergence.
However, another key driver of discounts, which is, admittedly, somewhat squishier and less observable, is alpha. A fund that can generate a higher amount of consistent alpha should rightly trade at a higher valuation.
There are different ways to define alpha - we do it as an average pairwise risk-adjusted return of a given fund against all the other funds in the relevant population. Relative to the other PIMCO CEFs, the alpha of BIT is on the low side which is just a function of its middling returns and fairly elevated NAV volatility.
Source: Systematic Income
And although the BIT discount is wider of PIMCO CEFs, it is fairly tight relative to the BIT's own history. The chart below shows that the historical differential between the BIT discount and other multi-sector CEFs has compressed significantly.
Takeaways
For investors looking at alternatives to the taxable PIMCO CEFs, BIT offers a broadly similar sector allocation at a similar leverage and a lower management fee. The fund's duration profile is also unusually negative which can offer support in an environment of rising rates. The fund's discount is more attractive and the fund has proved nimble in navigating the COVID crash, outperforming all PIMCO CEFs in 2020 in NAV terms. There is no free lunch, however, as BIT has delivered lower (though still respectable) longer-term returns versus PIMCO funds and its risk-adjusted returns are also on the low side. Its NAV drawdown was also surprisingly high in March of last year. All in all, BIT may be attractive to investors who are concerned about a market sell-off due to a rising rate environment. The fund's wider discount and its negative duration should allow it to perform well in such an environment.
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This article was written by
ADS Analytics is a team of analysts with experience in research and trading departments at several industry-leading global investment banks. They focus on generating income ideas from a range of security types including: CEFs, ETFs and mutual funds, BDCs as well as individual preferred stocks and baby bonds.
ADS Analytics runs the investing group Learn more.Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (16)
My (admittedly hot button) issue with Blackrock on this and some other CEFs is this: there is nothing at all wrong with running a lower-income high-total return fund ---- but phoneying it up as a high income fund with an apparently unearnable "managed" (read "deceptive") distribution. It is not a fund to be ashamed of ---- so why the high BS-coefficIent characterization?
Larry Fink certainly doesn't care what I think of BIT, but I've always thought Blackrock was better than this.
Regards, Dick
It won't get me a second time.
ADS
Thanks